Wednesday, December 6, 2017

Store of value

LSD tabs like these ones have an incredibly high value-to-weight ratio

When bitcoin first appeared, it was supposed to be used to buy stuff online. In his 2008 whitepaper, Satoshi Nakamoto even referred to his creation as an electronic cash system. But the stuff never caught on as a medium-of-exchange: it was too volatile, fees were too high, and scaling problems resulted in sluggish speeds. Despite losing its motivating purpose, bitcoin's price kept rising. The bitcoin cognoscenti began to cast around for a new raison d'etre. Invoking whatever they must have remembered from their old economics classes, they rechristened bitcoin as the world's best store of value.

Store of value is one of the three classic functions of money that we all learn about in Money and Banking 101: money serves a role as a medium of exchange, unit of account, and store of value. So presumably if bitcoin wasn't going to be a medium of exchange (and certainly not a unit of account thanks to its volatility), at least some claim to money-ishness could be retained by having it fill the store of value role.

In his 1867 Money and the Mechanism of Exchange, political economist William Stanley Jevons formally introduced the term store-of-value into monetary economics (although Nathan Tankus tells me that Marx may have originated the idea albeit with different terminology, and Daniel Plante tips Aristotle):

Jevons's store of value function refers to the process of preserving value across both time and space. Now in one sense, every good that has ever existed has been a store of value, as Nick Rowe once pointed out. If a good isn't capable of storing value, we'd be incapable of handling and consuming it. Even an ice-cream cone needs to exist long enough for value to be transferred from tub to mouth.

What Jevons was implying in the above passage is that some goods are better than others at condensing value. Goods with the low bulk and weight, including the "current money of the land" (i.e. banknotes), are the best condensers. Below is a list of items ranked according to price per pound, which I get from Evilmadscientist (beware, these are 2008 prices). While all-purpose flour can store value, a $100 bill is better at the task, and while both are surpassed by championship thoroughbred semen, nothing does the job better than LSD.

To condense value over time and space, a store of value will need to be durable. Saffron has a fairly high value-to-weight ratio, but its quality depreciates much quicker than a dollar bill, thus compromising its ability to store value through time. Same with copper and silver, both of which will steadily corrode whereas gold does not. It also helps to have low storage costs. Oxen may have been a great way to store value across space, yet feeding and sheltering them over long periods of time would have been quite expensive. 

Jevons was writing before computers and the internet had emerged. Nowadays, billions of dollars in value are represented digitally. These digital tokens—stocks, bonds, deposits, credit, bitcoin, and whatnot—are weightless and volumeless. Which means they far exceed the ability of any physical item to condense value over time and space.

How does bitcoin rank relative to other digital stores of value? Let's say you needed to condense a certain amount of value and had a choice between either holding bitcoin or Netflix stock. (I choose Netflix because its market cap is close to the market value of all bitcoins ever mined, and because both their prices have done exceptionally well over the last six years). Bitcoin is great for conveying value across space, especially if it involves crossing national borders. All you have to do is remember your private key and you can access your funds no matter where you are. Netflix isn't quite so fluid. While you can certainly access your online brokerage account when you are in Vietnam on holiday, you can't actually sell Netflix stock in Vietnam (as you presumably could with bitcoin). Instead, you'd have to sell the stock and transfer the proceeds to a bank account in Vietnam via the correspondent banking system. That could take a few days and you might run into some hassles.

What about for storing value across time? Bitcoin has a few neat features, including censorship resistance. Since bitcoin isn't centrally managed, there is no way for an administrator to censor you, i.e. erase your bitcoins. With Netflix (or any other centrally-housed digital asset), however, if you are a considered to be a bad actor by those who control the system, presumably your shares can be frozen or confiscated. Counterbalancing this, bitcoins are notoriously susceptible to being stolen. But I've never heard of a thief getting away with someone's shares. There's a bit of give and take.

But in general, I'd argue that bitcoin and Netflix stock are both pretty bad for temporally storing value, although bitcoin is particularly bad. For an asset to do a good job condensing property over time it has to provide its owner with predictable access to a future basket of consumption goods. Assets with prices that have gone parabolic do not fulfill this requirement. After all, there is no reason that the price won't reverse and start to plunge, thus compromising that instrument's ability to store predictable amounts of consumption through time. Anything with a highly stable price across all time frames (minute-by-minute and year-to-year) provide the requisite predictability. Assets that gyrate do not.

The chart below shows the relative variability of the prices of bitcoin, Netflix, and gold since 2011.

Specifically, the chart measures each assets' median change in price over a given month. For instance, in November 2017 bitcoin had the tendency to close up or down by around 3.2% each day, Netflix by 0.8%, and gold by 0.3%. Averaging out all months since 2011, gold's variability comes in at 0.5%, Netflix at 1.5% and bitcoin at 2.2% (see dashed lines above), which means the yellow metal has done a much more predictable job of storing value over time than the other two assets, and Netflix is more up to the task than its digital counterpart. 

In late 2016 bitcoin's volatility seemed to have fallen permanently below Netflix levels and—for a month or two—approached that of gold. The digital stuff had become a mature asset! That wasn't to be, however, and bitcoin volatility has since reverted to levels significantly above its long term average.

I'd argue that bitcoin's high volatility is inherent to its nature. As such, it will always do a fairly bad job of storing value over time. The problem, as I outlined in my recent BullionStar article, is that bitcoin is a pure Keynesian beauty contest asset. People only buy bitcoins because they expect others to buy them at a higher price. The markets for gold and Netflix, on the other hand, are populated by a second set of participants who value those assets for reasons apart from whether others will buy them later. In the case of gold, industrial buyers step up whereas with Netflix it is value investors. The buying and selling of this second set of participants has a calming effect on prices.

The most predictable way to condense value through time is a U.S. dollar deposit. Anyone who has $100 in their account knows with a high degree of accuracy what they'll be able to buy next week. This stems from the fact that consumer good prices are measured in terms of the units issued by the central bank, and retailers keep these prices fairly rigid over the short term. For longer time periods, say one year out, the U.S. dollar will have naturally suffered from some inflation. But this decline in purchasing power is a known quantity. The Federal Reserve has an inflation target of 2%. So it's a safe bet that $100 will be worth $98, not $92, or $84, or $104. That's pretty good predictability. Interest earned on the deposits will make up for the lost purchasing power.

So is bitcoin a store of value? Sure, everything is to some degree... and bitcoin certainly does a good job of condensing value across distances. But relative to other assets, in particular U.S. dollar deposits, it does a poor job storing value across time. I don't think this is going to change, but I could be wrong.

P.S: In the interest of full disclosure, I still own some bitcoin and XRP, not much though. Own some gold too, but no Netflix.
P.P.S: Here is a rewrite of Satoshi's whitpaper, substituting in store of value system for electronic cash system:


  1. It's characteristically disingenuous of you to suggest that bitcoin cannot be used as a medium of exchange. It's still by far the best medium for large value exchange, and will be for low value exchange once layer 2 solutions (such and Lightning and Sidechains) are ready.

    1. Hi Anon,

      Could be. But bitcoin wasn't used as a medium of exchange when transaction times were still fast and fees low, so I don't know why Lightning would suddenly make it popular in small transactions.

      Where has it become common to use bitcoin in large value exchanges? I haven't seen any evidence of this.

    2. Your claims are demonstrably false. Just look at the blockchain.

    3. I told you: look at the blockchain. You wrote the blog post professing to know everything about bitcoin's usage profile, so back it up.

    4. The blockchain doesn't tell us whether a transaction was for speculative purposes or whether it was used as a medium of exchange... ie. used to purchase things like cars or houses. We need to look at actual payments habits, and on that front I just don't see any evidence of large value bitcoin payments becoming a generally-accepted practice.

    5. Fun article, got a kick out of the LSD and human blood measures.

      "The blockchain doesn't tell us whether a transaction was for speculative purposes or whether it was used as a medium of exchange"

      Agreed. And that is the beauty of it, a transaction on the blockchain could also simply by me moving my coins to a different wallet, but because of that its very difficult to know if it is being used or not for a medium of exchange. I think the only way we would really get an idea of it is to look at the largest bitcoin accepting markets and see what their transaction volume looks like (since it will most likely be listed in revenues) in fact Overstock a while back claimed they received 800 orders paid in bitcoin in the first 22 hours of opening up bitcoin payments. I'd like to figure out how many bitcoin transactions these companies are receiving.

      all we really know is the number of confirmed transactions per day has hovered around 300,000 (of varying amounts) and if we look at Amazon packages shipped a day is 3,000,000 while Alibaba is 12,000,000. meaning if we assume confirmed transactions as "packages shipped" because in a way they are transactions made, then we see bitcoin is at most roughly 10% of the transaction volume of Amazon. but this could and probably is much lower due to the reason listed above, that transactions are always purchases.

      I should really make an account, I always chime in on these topics. We discussed baked in fork prices before JP.

    6. Hi anon. Are you the same anon as @December 11, 2017 at 12:28 PM? If you don't like using your real name, just use a pseudonym. That way there is continuity between comments from post to post.

      "I think the only way we would really get an idea of it is to look at the largest bitcoin accepting markets and see what their transaction volume looks like."

      Yeah, I pretty much agree with all of that.

      As a gauge for measuring uptake of bitcoin use as a medium of exchange I also monitor my circle of friends/colleagues/family as well as businesses that I frequent --- and none of these give any indication that bitcoin has become a popular money.

  2. Great post, actually, the volatility chart well done.
    I think of bitcoin as an ad hoc FX transfer tool, simulated cash done on the open web. Its primary users being insiders hedging future CB and regulation shocks. Kind of like a mechanically managed SDR unit of account.

    1. Thanks, glad you liked it.

      Not sure about the SDR analogy, an SDR is really just US dollars and euros.

  3. There is complementary value to store of value and that is volatility. This value is not a value to investors but is a value to speculators. They want to be able to sell at a higher price, but have little interest in perpetually higher prices. They hope to make money on the swings rather than holding. This is sustainable as long as more liquidity enters the market. Once it flows out the odds of becoming stranded become large. Mania and panic are endemic.

    1. I never met a long who wasn't interested in a perpetually higher price.

  4. I'd argue that as long as Bitcoin appreciates in the long term the trade-off with volatility is something most long term savers would be willing to accept. Today people choose stocks over bank deposits for the same reason. The transparency of Bitcoin (knowing the supply in advance) along with the network effect makes me think it can continue to steal "market share" from other asset classes going forward and it will be because of the store of value function.

    I found this old post by Mencius Moldbug quite interesting on the subject:

    1. Yep, some of moldbug's stuff on bitcoin was pretty good.

      "I'd argue that as long as Bitcoin appreciates in the long term the trade-off with volatility is something most long term savers would be willing to accept. Today people choose stocks over bank deposits for the same reason. "

      Good point, but my blog post was about the concept of store-of-value as described by Jevons, not the idea of savings. Stocks aren't great stores of value because they are quite volatile. But that doesn't mean people don't like to save in the form of stocks. The instruments and objects we hold as savings can be both good and bad stores of value.

    2. My knowledge of Jevons only extends as far as your quote but it seems to me he was writing about hoarding, which is the same as saving is it not? If there is a distinction between what is good for saving and what is good as a store of value I don't think the Bitcoin fans make it when they claim that it is a good store of value, they simply mean it is a good vehicle for saving. And if it is they then have a motivating purpose.